Inheritance Tax planning is becoming an increasingly crucial consideration for many families, with the number of estates expected to be subject to it ever on the rise. So, what can be done about Inheritance tax? In this, the second video of our IHT mini-series, we will cover some of the planning options available to you, as well as the pros and cons of each and how they can work for you in practice.
Hello, and welcome back to our inheritance tax (IHT) mini-series. I’m Elliot Unsworth, Head of Client Proposition at Astute Private Wealth, and in this video, we’ll explore the options that are available to you to potentially mitigate or cover an eventual IHT liability. In this particular video, we will be focusing on Will writing, lifetime gifting and making the most out of the exemptions that are available to you.
According to research by Canada Life, over half of UK adults do not have a will! A Will is a vital legal document that ensures your assets are distributed according to your wishes after you pass away.
On the government’s own website, they make it clear that by making a will, you can “make sure you do not pay more inheritance tax than you need to”! Without a Will, the rules of intestacy apply; these are a strict set of rules that determine who is entitled to your assets, starting with spouse or civil partner, and children, then parents and then siblings before venturing further into the family tree. Often, these rules might not align with your intentions and could lead to unnecessary stress for your loved ones. Even if your affairs are simple and the rules of intestacy suit your wishes, the administration of your estate through these means is a long-winded and drawn-out affair and is best avoided all round. As such, we always recommend you have a valid Will in place. Furthermore, we recommend that you work with a financial planner alongside a legal professional to ensure that your affairs are joined up.
Before we get started, if you have the benefit of working with Astute and this video raises any questions, then please don’t hesitate to get in touch with your Astute financial planner.
There is no “best way” to draft a Will; it certainly isn’t a ‘copy and paste’ job, and the contents will depend entirely on your personal circumstances and your wishes. When drafting a Will, it’s important to be as specific as possible. This includes naming your executors (the individuals you want to handle your estate after you’ve gone), as well as detailing the distribution of your assets, and considering any contingencies.
Whilst all of this is important, we’re here to focus mainly on how a Will can be used to effectively mitigate IHT. When IHT planning, there are many complex options available, but it is always preferable to keep it simple where possible, and some very effective planning can be put in place for certain individuals just with a Will.
Before we continue, we’d like to make you aware that we went into detail about how various IHT allowances work, how much they are when they apply, and when they are tapered away in the first video of this series. If you haven’t watched that video and would like further information about the basics, please go back and watch that one first.
It is important to recognise that if you leave assets to anyone other than a spouse/civil partner, there could be IHT implications. Every £1 left to a non-spouse/non-civil partner uses £1 of your available nil-rate band, and should the nil-rate band be exceeded, then IHT will apply at 40%.
The takeaway here is knowing that if you leave a non-spouse/civil partner capital in excess of your available nil-rate band in your Will, there will be IHT to pay immediately, whereas with some planning, IHT can be levied on second death. An IHT liability becoming apparent on first death can easily be done by accident; for example, if you leave a second property to a child on the basis that it wasn’t worth a great deal when you wrote the Will, but by the time you die, the value has surged upwards and has now created a problem.
Let’s use an example: John & Jane are not married. If John leaves all his assets to Jane, as a non-spouse/civil partner, the whole amount over £325,000 would be subject to IHT at 40%. Jane would then receive this money, and when she dies, everything over £325,000 would be subject to IHT at 40% – including on money that was already subject to tax when John died – effectively a double IHT taxation on what were John’s assets. It’s worth noting here that if Jane dies within 5 years of John, quick succession relief can be claimed to reduce the tax payable.
In this scenario, John could have been better off leaving his assets to a Trust; IHT would still be payable on his death, but it would prevent this capital from forming part of Jane’s estate and being subject to a second round of IHT on her death, while still allowing her to benefit from the capital. Don’t worry too much about Trusts for now, as these will be talked about in great length in our next video. The point, for now, is to demonstrate how important the terms of a Will can be when it comes to considering IHT.
Next, let’s consider the other IHT allowance that we introduced in the previous video, the Residence Nil-Rate Band. As a quick refresher, this is an allowance of up to £175,000 (or £350,000 for a couple) that can be used against a main residence under the right conditions. This allowance is tapered away by £1 for every £2 an estate is above £2mn. To demonstrate the power of Will planning from the perspective of this allowance, let’s return to an example we used in the previous video.
John and Jane, who are married, have a combined estate of £2.3mn, owned 50:50 exactly, including a home worth £500,000 that they are leaving to their children. John dies and leaves his £1.15mn to Jane; as his estate was less than £2mn, his Residence Nil Rate Band remains intact at £175,000. Jane subsequently passes away with an estate totalling £2.3mn. Ordinarily, she would be entitled to her own Residence Nil Rate Band as well as John’s, totalling £350,000, however because her estate is over £2mn, her allowance starts to reduce. In this case, being £300,000 over the threshold reduced her allowance by £150,000, down to £200,000. Her total allowances are, therefore, £650,000 plus £200,000, resulting in an IHT liability of £580,000.
Now let’s consider the position if John’s Will bequeathed £300,000 to his son, and the remainder of his estate to Jane. John & Jane were prudent enough to engage their Financial Planner in a cashflow forecasting exercise, which determined that Jane could live comfortably for the rest of her life without this £300,000. In this case, there is no tax to pay on John’s death as the £300,000 is covered by his nil-rate band, and everything else is covered by the spousal exemption. As his estate was less than £2mn, his Residence Nil-Rate Band is unaffected. Jane now has an estate of £2mn, so when she dies, her Residence Nil-Rate Band is not subject to the taper. This means her allowances are £350,000 (which is her own nil-rate band plus John’s unused nil-rate band of £25,000) plus both untapered residence nil rate bands of £350,000 – allowances totalling £700,000. On an estate of £2mn, this leaves a tax bill of £520,000 – a saving of £60,000 compared to the previous scenario.
Finally, on the subject of Wills, there is another way to create tax savings by bequeathing at least 10% of your net estate to charity. If you do this, not only do the transfers to charity not utilise any of your nil-rate band, but the rate of IHT levied on the rest of your estate reduces to 36% from 40%. It’s a good way of saving tax whilst giving back to important and worthy causes that you may have admired in your lifetime, but do note that because of the provision left to charity, your other beneficiaries will ultimately receive less money, even with the reduced IHT burden.
So, as you can see, there are plenty of reasons to ensure that the contents of your Will are appropriate with the input of a professional Financial Planner.
Now let’s move on to the second section of this video, which is about one way to reduce your IHT liability during your lifetime: gifting. By giving your money away during your lifetime, you will hopefully reduce the size of your estate and, in turn, reduce your eventual IHT liability, but it’s crucial to understand the rules around this.
Firstly, each individual is entitled to an “annual gift exemption” which allows them to gift £3,000 per year, and this money is considered immediately out of your estate. If not used in any one year, this allowance can be carried forward one year, so if you did not make any gifts last tax year, your allowance for this tax year is £6,000. There are also some special one-off gifts that can be made tax-free. It is a common misconception that exceeding your annual exemption has tax consequences, and many people are hesitant about making sizeable gifts to family in the belief that they will have to pay some tax. The reality is quite different to this, and to understand it, we need to explore how gifts are treated from an IHT perspective. In this video, we will be talking only about outright gifts to individuals.
Any gift made outright to an individual above the annual gift exemption consumes some of your available nil-rate band for 7 years. Should you survive 7 years, the part of your nil-rate band that was being consumed is restored in full to you, and the capital gifted is simply removed from your estate and eventual IHT calculation.
So, the reality is that you can gift whatever you want to an individual, and there are only tax implications if you die within 7 years – nothing is payable immediately. There is a quirk to be aware of where you have made a gift that is in excess of your nil-rate band, and then you die, so we’ll explore how this all works with a few examples.
John has an estate valued at £806,000 and available allowances of £500,000; his standard nil-rate band and his Residence Nil-Rate Band. Today, John gifts £306,000 to his son; firstly, we note that as John has not made any gifts before, the first £6,000 is disregarded under the Annual Gift Exemption.
If John dies tomorrow, the gift will fail and will consume £300,000 of his nil-rate band. This means that when assessing John’s estate for IHT, his allowances total only £200,000. As such, his remaining estate of £500,000, less his allowances, will be taxed at 40% – a liability of £120,000.
If John survives 7 years, his nil-rate band will be restored to him in full, meaning his allowances total £500,000 again. When John dies, his remaining estate of £500,000 is covered in full by his allowances, and the tax to pay is nil. A valuable saving, and John has also been able to watch his son put the money to good use and enjoy it, which is priceless.
Now, that quirk we mentioned earlier involves where an individual makes lifetime gifts in excess of their available nil-rate band, so we’ll take a look at an example of that now.
Jane’s estate is currently valued at £500,000, and in the past 7 years, she has made the following gifts: £100,000 8 years ago, £125,000 5 years ago and £300,000 last year. Jane died this year. The gift made 8 years ago is outside the 7-year rule, and so it is simply ignored. The remaining gifts are failed PETS, and each one is assessed in chronological order to establish how much of her available nil-rate band has been consumed. For ease of maths here, I’m going to assume that Jane has also been giving away £3,000 per year under the Annual Gift Exemption, and so this is not available when performing these calculations.
The gift made 5 years ago consumes £125,000 of her nil-rate band. The second gift consumes the rest of her nil-rate band, and so there is an excess over her allowance of £100,000 specifically on this gift. This means that IHT is due on this excess at 40% (so, £40,000), but the liability for this tax falls on the recipient of the gift – very important to know, as this can be quite a surprise for the recipient if they have not been made aware beforehand and have spent all the money! Then, when calculating the tax on Jane’s estate, her nil-rate band has already been consumed by the gifts, so only her Residence Nil-Rate Band is available, giving rise to an IHT liability of £130,000. This brings the total IHT bill to £170,000 payable.
Specifically concerning the tax due on the gift that was made last year (the £40,000 that is payable by the recipient), the older this gift is, the less tax is payable; this is known as “Taper Relief”. Taper Relief kicks in once the gift is over 3 years old, and gradually reduces the tax payable over the next 4 years by 20% each year. In our example, if the gift had been made over 5 years ago instead of 1, this tax liability would have been reduced to £16,000 using Taper Relief – definitely worth knowing.
Interestingly, any gifts made are immediately considered outside of your estate for the purposes of calculating any taper on the Residence Nil-Rate Band if your estate exceeds £2mn. We still have no idea if this was intended by the Revenue, but it is the current state of play.
The final method of gifting we will cover in this video is known as “gifts of our surplus income”; any gifts made using this rule are immediately exempt from IHT; no need to wait 7 years. The conditions to satisfy this rule are that gifts must be made from a genuine surplus of income (note: not capital withdrawals), making the gifts must not affect your normal lifestyle, and a pattern of gifting should be established over time. As long as these conditions are satisfied, there is no limit to the amount that can be gifted, other than it being limited by the size of your income surplus.
Outright gifts to individuals can be made for any value you like without any immediate tax implications – you just need to be aware of how these gifts will be treated should you not survive 7 years. There is also an interaction with gifts to Trusts that you will need to be aware of, but I don’t want to spoil anything for our next video. To understand the impact of making such gifts on your financial future, cashflow forecasting is invaluable. By modelling your income, expenses, and gifting plans, cashflow forecasting helps you see how much you can afford to gift while maintaining your financial security. It is also an effective way of evidencing that any gifts out of surplus income are indeed from surplus income.
Writing a Will is just the first step in a comprehensive estate plan. By incorporating tools like lifetime gifting, charitable donations, and exemptions, you can take a proactive approach to Inheritance Tax Planning. And with the power of cashflow forecasting, you can plan with confidence and peace of mind.
Thank you for joining us for this important discussion. In our next video, we’ll dive deeper into trusts and how they can be used to protect and manage your assets. Don’t forget to subscribe to stay up to date with our latest insights. See you next time.
